Capital Budgeting Process and Techniques for which project would you recommend a

Question

Capital Budgeting Process and Techniques for which project would you recommend acceptance? The first 3 Calculate the internal rate of return (IRR) proposal calls for a major renovation of the of each project, and based on this criteria, for which project would you recommend involves replacing just a few obsolete pieces of 4. Calculate the profitability index (PD) of The second equipment in the facility. The company will each project, and based on this criteria, for which project would you recommend acceptance? choose one project or the other this year, but it will not do both. The cash flows associated with each project appear below and the firm discounts project cash flows at 15 percent 5. Overal I, you should find ommendations based on the various cri- teria. Why is this occurring? 6. Chart the NPV profiles of these projects. -$2,400,000 Labe the intersection points on the X 2,000,000 and Yaxis and the crossover point. 200,000 200,000 7. Based on this NPV profile analysis and assuming the WACC is 15%, which s recom 8. Assignment 1. Calculate the payback period of each proj- Based on this NPV profile analysis and assuming the WACC is 25%, which proj- ect is ? Why? ect, and based on this criteria, for which 9. Discuss the important elements to con- project would you recommend accep-sider when deciding between these two 2. Calculate the net present value (NPV) of each project, and based on this criteria,

Explanation / Answer

9)

First, the discount rate for the projects needs to be evaluated. Discount rate increases with the riskiness of the project.

If the projects are as risky as the current operation of the firm then the discount rate of the firm can be used to calculate the present value of cash flows of the projects.

NPV of the project is the most reliable criteria to evaluate a project. Positive NPV means project adds value to the company. Therefore only projects with positive NPV should be accepted.

Since initial investment of the two projects are different, therefore profitability index of the projects needs to be calculated and compared. Higher profitability index means higher return per investment value. It is calculated by dividing the present value of future cash flows divided by initial investment. Project with higher profitability index should be accepted.

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